Will AIG Sue the Government?

American International Group (NYSE:AIG) has once again found itself between a rock and a hard place. The New York Times reports that the insurance company is thinking about joining a $25 billion lawsuit filed by former CEO Maurice Greenberg, who accuses the government of constructing an illegal and inequitable bailout.

Sounds like there’s some bad blood here. What’s the scoop?

Once the world’s largest insurer, AIG received what has become one of the most controversial bailout packages of the financial crisis — $182.3 billion from the New York Fed and U.S. Treasury in return for a nearly 80 percent stake.

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After the collapse of Lehman Brothers and accumulating losses from bad mortgage debt at a frightening rate, the company’s management had no choice but to accept the bailout on whatever terms the government offered, or face bankruptcy. With every passing minute fueling the financial collapse, the entire process was rushed and, as a result, different stakeholders and creditors received different treatment. For example, JPMorgan Chase (NYSE:JPM) was fully reimbursed for nearly $10 billion in debt, while unwinding billions in credit default swaps left many others in the dust.

Among those who received the short end of the stick is the very-same Maurice Greenberg, who headed AIG for nearly 40 years before his alleged involvement in an accounting scandal led to his removal. He remains chairman and managing director of a financial services company called Starr International, which with a 12 percent stake was once AIG’s largest shareholder.

By nearly any definition, the bailout of AIG was distressed, and Greenberg argues that the Fed’s conditions were not only inequitable, but relative to the bailouts of other companies such as General Motors (NYSE:GM), the government behaved like a loan shark…

The $85 billion credit line extended to the collapsing insurer came loaded with a 14.5 percent interest rate. Greenberg has built a case that he and other shareholders were robbed of tens of billions as a result, and that the government violated the Fifth Amendment. That is, even if the government is trying to stave of total economic ruin, it does not have the right to seize bad assets.

AIG has since paid back the bailout and then some. The government has logged a nice profit of about $22 billion, and on the back of a public-relations campaign highlighted by the slogan “Thank you, America,” the tenuous relationship between AIG and its bailout partner seems to be healing. That is, minus Greenberg and his bone to pick.

The New York Times Reports: “The choice is not a simple one for the insurer. Its board members, most of whom joined after the bailout, owe a duty to shareholders to consider the lawsuit. If the board does not give careful consideration to the case, Mr. Greenberg could challenge its decision to abstain.”

The case, filed in both New York and Washington D.C., was dismissed by a New York judge in November. In D.C., a judge has allowed the case to proceed and is waiting on AIG’s decision on whether to join. When U.S. District Judge Paul Engelmayer decided to dismiss the case in New York, he ruled that the NY Fed acted in the best interest of the U.S. economy and prevented what would otherwise have been a far more devastating financial collapse. While this is in many ways an endorsement of the government’s action, it is by no means clear that the D.C. judge will see the bailout in the same light.